Rights Vs FPO

This is another bit in my series of stock market basics (advanced readers please skip the post)

India is a booming economy and as the companies expand their operations, they need more and more of capital to fund it. Sometimes the company is able to raise these funds by issuing bonds, taking loans from Banks, internal cash flow etc. but often when the company is expanding exponentially its advisable to issue a fresh set of equity and raise funds by selling it. This could be done via Rights or via FPO.

FPO: Further public offering:
Its much like an IPO, but its an IPO of an already listing company.

Concerns of FPO:
Usually people accuse the promoters/management of a company raising money through FPO of diluting the equity and not rewarding the shareholders adequately.
But if the management is good, then the reality is just the opposite.
an FPO usually happens when the stock price is at all time high. So in reality the FPO induces a stickiness in the price. (People rarely like to book losses, esp in a good company.)
Secondly the funds raised only enables the company to continue its exponential growth and hence benefiting the stake holders (both post and pre-fpo)
Thirdly the very fact an outsider is ready to pay the price for the share is a display of the company’s strong fundamentals.
So an FPO is actually a good thing for the minority stock holders.

Rights Issue:
Its is almost like a FPO i.e.:
1. Fresh equity of an already listing company is raised.
2. The fresh equity is always at a discount from the prevailing market rate (except a rare case where the promoter issues rights share instead of warrants to raise his holding)

However the only difference is that:
1. in the rights issue, only the existing share holders are allowed to subscribe. So the shareholding pattern does not get significantly altered.
2. The allotment would be in proportion to the existing shareholding pattern on the record date. So one does not have to worry about over subscription and hence no/low allotment.
3. The FPO is usually at the prevailing rates (or at a 5% discount) so that the existing shareholder’s interests do not get hurt. But the rights issue is usually a significant discount from the prevailing market rate to encourage subscription and also enable the existing share holders to save taxes by booking paper losses.
4. This discount in prices leads to a significant fall in the share price of the company (post record date)… (but now since the investors have more shares, their wealth does not alter) And this fall gives room for booking of paper losses and getting tax shields.
5. But this introduces a downside. If a company issues a rights issue (at a significant discount) then the existing share holders have to invest in the company, else they will suffer a significant dilution of stakes and capital losses.

Usually the Rights issue is marginally under subscribed because some of the minority share holders are not able to submit their applications in time. There it is advised that who ever subscribes to the rights issue, should apply for slightly more than the guaranteed amounts and benefit from it.

PS: I have deliberately omitted all equations and charts. Please refer to investopedia for details.